Japan ageing crisis offers glimpse of future

Matthew Kidman

Every stockmarket investor in Australia should spend time scrutinising the events unfolding in Japan. The world's third-largest economy is akin to a window into the future and is rapidly becoming the test case for all other advanced economies, including Australia and the United States.

After several years of hiding in the shadows of the Chinese economic miracle, Japan has been catapulted back into the limelight following the election in December of the Liberal Democrat Party, with Shinzo Abe as Prime Minister.

As promised in the election campaign, Abe is attempting to halt Japan's 15 years of crippling deflation by targeting a 2 per cent inflation rate. To achieve this goal he has turned the fiscal burners on and strong-armed the Bank of Japan into printing unlimited yen.

Abe's policies have gravitas in financial circles. Since early November, when markets realised he would be elected, the Japanese stockmarket has hurtled 30 per cent higher while the yen has depreciated about 15 per cent against the greenback and the Aussie dollar.

For years the yen has been the whipping boy of the currency world, with the Japanese government seemingly powerless to stop the appreciation of its currency against its big competitors in the US and Europe. Japan's massive export industry had become uncompetitive, but in the space of just two months it is back in the game.

Why are these events suddenly so important to Australian and other investors around the world? Primarily because Japan is the test case for virtually every other developed and developing country on earth. It is a glimpse of our future. With a median age of 46 for its people, Japan sits only behind the principality of Monaco as the oldest population on earth. If projections are correct, this lead will narrow with its population precipitously growing older and its workforce shrinking in size.

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Japan's total population peaked in 2008 at the 128 million mark and is forecast to slump to about 90 million by 2050. Moreover, the working population of people in the 15 to 64 age group peaked between 1990 and 1995 at some 68 per cent of total population. It now sits at 62 per cent. At the same time the proportion of people over 65 has risen from about 14 per cent to 24 per cent of the population. By 2050 the over 65s will be 40 per cent of the total population.

These numbers are frightening. In its 18 years of a shrinking working population and deflation, Japan's government has tried to stimulate economic growth by running massive fiscal deficits and printing yen. It invented quantitative easing (QE) and despite QE's ineffectiveness, the move has been copied in the US, Britain and more recently the European Union .

Today, Japan has the largest fiscal deficit of any developed country sitting on 230 per cent of gross domestic product. This addiction to debt has been funded by high levels of domestic savings. From the 1970s to the 1990s the average Japanese citizen saved about 15 per cent of income, making it possible for the government to keep racking up deficits year in year out.

Critically, these dynamics are about to change. With the Japanese population growing older at a rapid clip, private savings have fallen to just 3 per cent of incomes and by 2015 people are forecast to start dipping into their savings. Abe is acutely aware of this situation and is desperate to crank up the economy to offset this pending disaster.

The US based investor Kyle Bass and the Harvard economist Martin Feldstein have both warned about the perils of Abe's policies. They believe targeting 2 per cent inflation will drive Japanese interest rates higher, making it near impossible for the government to meet its debt funding. At present, the interest bill on the government debt eats up 25 per cent of all tax receipts.

A spike in interest rates would send this percentage soaring. Bass claims Abe is not helping the economy out of its funk but simply bringing forward the day of reckoning when the Japanese government defaults on its debt.

Abe's bold attempt to avert disaster must be closely analysed by investors and public officials. Australia's median age is about 38 years but forecasts put this number at 45 years, the same as Japan, somewhere between 2040 and 2050. The US is in a slightly better position but is heading down the same path, while the main European countries are only a decade behind Japan.

Australia must not go down the same path as Japan of trying to prop up economic growth via an expansionary fiscal policy.

As a nation it must continue to replenish the working population and try to keep it in the realms of 65 per cent of the overall population. Otherwise, it will fall into the same trap as the Japanese and more recently the main European nations of increasing our fiscal deficit to maintain the standard of living while the private community saves for retirement.

Another important step for the domestic economy is to heighten productivity levels. Increased productivity allows economies to grow at healthy rates without putting upward pressure on inflation and avoids Keynesian-like intervention through regular government deficits.

Australian productivity levels have dropped in relative terms over the last decade, a point not lost on our business leaders.

Unfortunately, the business community blames this unnerving trend on the government rather than sharing the responsibility.

Australian business has been slow to react to many trends since the global financial crisis, letting everyone down including their own shareholders.